To help poor people, give them money (Draft excerpt from Economics in Two Lessons)

Here’s another draft excerpt from my book in progress, Economics in Two Lessons. To recap, the idea of the book is to begin with the idea that market prices represent opportunity costs for the households and business who face them (Lesson 1), and then go on to explain why market prices won’t in general equal opportunity costs for society as whole (Lesson 2). A lot of the book will be applications of the two lessons, and this section is an application of Lesson 1.

As before, all kinds of comment and criticism, from editorial points to critiques of the entire strategy are welcome.

To help poor people, give them money

The problem of poverty is huge, in rich and poor countries alike. Around the world, nearly a billion people live in extreme poverty, living on less than $US1.50 a day. Even in the United States, on many measures the wealthiest country in the world, the Dept of Agriculture estimates that 14.5 per cent of the population experience food insecurity, defined as being ‘uncertain of having, or unable to acquire, enough food to meet the needs of all their members because they had insufficient money or other resources for food.’

Faced with images of the hunger and suffering caused by famines and extreme poverty, a natural and intuitive reaction is to send food. This reaction is often politically appealing in countries that happen to have large stockpiles of food, either because of unforeseen declines in market demand, or because of government policies such as price supports for farmers.

On the other hand, many advocates of development aid dismiss food aid as a short-term ‘band-aid’, and argue that the aim of aid should be to provide the ‘right’ kind of assistance, as measured by subsequent economic growth. Advocates of aid initially focused on economic infrastructure and industrial development, and have more recently turned their attention to health and education.

Similar debates have played out in the United States. The Supplemental Nutrition Assistance Program (SNAP), better known as food stamps, has played a central role in US programs to assist low-income households since it was introduced in 1964. With cuts in other welfare programs, its importance has increased over time.

On the other hand, as with international food aid, the SNAP program is regularly derided as a bandaid approach. Liberals frequently point to education as the way to provide real opportunities for the poor.

Which of these approaches is right? Much of the time, neither. While support for health and education has a better track record than food aid, there is a growing body of evidence to say that, in both poor countries and rich ones, the best way to help people is to give them money.

To see why this should be so, ask: What would a desperately poor family do with some extra money? They might use to stave off immediate disaster, buying urgently needed food or medical attention for sick children. On they other hand, they could put the towards school fees for the children, or save up a piece of capital like a sewing machine or mobile phone that would increase the family’s earning power.

So, the poor family is faced with the reality of opportunity cost. Improved living standards in the future come at the cost of present suffering, perhaps even starvation and death. Whether or not their judgements are the same as we would make, they are in the best possible position to make them.

This is a straightforward application of Lesson 1. Market prices reflect (and determine) the opportunity costs faced by consumers and producers.

Exactly the same points apply in rich countries. Giving poor people assistance in kind, such as food stamps and subsidized housing, has a lot of political appeal. Not only does it meet an apparent need, but it appears to reduce the chance that the recipients will waste their extra income on luxuries, or on alcohol and tobacco. In addition, as in the case of the US food stamps program, it may also be possible to form a political coalition with producer interests, represented by the farm lobby.

Thinking in terms of opportunity cost, however, we can see that aid in kind almost inevitably results in waste. The opportunity cost of subsidized housing is the low rent paid for the house, while the opportunity cost of moving usually includes going to the back of the line. So having secured subsidized housing, people will stay there even if the house no longer suits their needs, because it is too big, too small, or too far away from a new job.

The same kinds of problems come up with food stamps. Families poor enough to get food stamps face all kinds of problems. They might, for example, need urgent medical or dental care, or be faced with eviction if they don’t make a rent payment.

Most of the time food stamps cover only part of a family’s food budget, so they are really just like cash. Families can meet some of their food bills with stamps, then use the money they save to meet other needs The opportunity cost of spending more on food is the alternative that can’t be afforded.

But it’s precisely when people need money most, to the point where they are prepared to live on a restricted diet, that the limits of food stamps start to bite. If poor families were given money, they could choose to pay the rent bill even if it meant living on rice and beans. That’s a hard choice, but it might be the best one available.

Unsurprisingly, then, poor people often try to change some of their food stamps for money. This is denounced as ‘fraud’ and used as a reason for cutting food stamps even further.

It is market prices that determine the opportunity costs of goods and services for individuals and families. So, when people choose how to spend additional money, the opportunity cost of one choice is the alternative that could be bought for the same amount.

The idea that poor people don’t understand this is patronizing and wrong. The tighter are the constraints on your budget, the more important it is to pay attention to them. Poor people often have less access to markets of all kinds, including supermarkets basic financial markets such as bank accounts and face complex and variable prices as a result. Nevertheless, many of them manage to find highly creative ways of stretching a limited budget to meet their needs. Additional constraints, in the form of payments that can only be spent in particular places and on particular goods, are the last thing they need.

These arguments have been going on for many years, but resolving them has proved difficult, since there are usually many different factors that determine good or bad outcomes for poor families. In recent years, however, a combination of improved statistical techniques and careful studies of experimental program pilots have allowed an assessment of the evidence to emerge. Overwhelmingly, it supports the view that giving people money is more effective than most, if not all, forms of tied assistance in improving wellbeing and life outcomes.

If the best way to help the poor is to give them money, what is the best way of doing that? In a market economy there are two possible answers. The one that has been discussed most is redistribution; that is, using the taxation and welfare systems to transfer some market income from the rich to the poor. More difficult, but arguably more effective is to change the structure of markets and property rights to produce a less unequal distribution of market income — this is sometimes called ‘predistribution’. We will come back to this issue later.